We found two exploration companies and a pair of MLPs poised to reward investors over the coming year.
It's not too late for investors to get a piece of the great American energy boom.
The companies rushing to take advantage of hydraulic fracturing technology to exploit shale deposits around the country are producing three commodities: oil, natural gas, and "natural-gas liquids," whose byproducts have a variety of industrial uses. While the natural-gas frenzy has resulted in oversupply, prices for oil and liquids have held up. Those companies with the balance sheet strength to fund investment in domestic oil and liquids production should reward investors.
For different reasons, the share prices of these two explorers and two Master Limited Partnerships don't fully reflect their prospects. And each pays a yield to boot.
SM Energy (ticker: SM) is an exploration and production company with prospects for a double-digit increase in 2013 production. Thanks to a selloff last year, SM looks cheap, and Macquarie Analyst Joseph Magner thinks shares could rise 33% to $74 over the next year -- and still trade at a discount to peers.
SM's reserves are split more or less evenly, with half in natural gas, and half in liquids and oil, and the Denver-based company has refocused spending on the more profitable liquids and oil.
After lower production guidance, asset sales and losses last year, SM shares are trading at a deeper-than-usual discount to other producers. And many of those peers have weaker balance sheets and cash-flow prospects as they shift to liquids. SM, formerly known as St. Mary Land & Exploration, is further along in the process, and has ample borrowing capacity.
SM's $1.5 billion spending plan for 2013 is focused on developing productive resources in the Eagle Ford Shale in Texas, the Bakken/Three Forks in North Dakota, and emerging-oil formations in the Permian Basin in Texas. In the Eagle Ford, with construction of new pipelines and processing facilities planned, and a partnership with well-funded Anadarko Petroleum (APC), production should grow by nearly 20% this year, Magner says.
A larger exploration name that also should benefit from the domestic shift to oil and liquids projects: EOG Resources (EOG), once part of Enron. While its natural-gas reserves are significant, it invested early and at a low cost in the Eagle Ford and has considerable oil acreage there.
"This is a stock that could easily appreciate 20% a year for several years because of the investments they have made," says Todd Smurl, lead portfolio manager of theAscendant Natural Resources Fund (NRGAX). "At some point, the market will price it appropriately." While EOG shares have risen 21% over the past 12 months, outperforming many E&Ps, Capital One Southcoast believes shares can jump another 18% to $148. That target is based on higher-cash flow from EOG's Eagle Ford and Bakken projects.
While SM and EOG have outspent cash flow in recent years, their long-term debt-to-capital ratios are reasonable and balance sheets are improving. And each stock pays a small dividend.
Investors looking for fatter yields have been flocking to MLPs, which pass on most of their cash flow as tax-deferred distributions and are paying 6% yields on average.
Despite their decade-long ascendance, MLPs underperformed the broader market in 2012 due to fears about rising taxes. But with the fiscal cliff resolved, the Alerian MLP Index is up nearly 8% in the first two weeks of January, beating the 4.7% return of the Standard & Poor's 500 Index.
Gregory Reid, the senior portfolio manager at MLP-focused Salient Partners, likes Targa Resources Partners (NGLS), which could boost distributions by 10% to 12% this year, strengthening its already attractive 6.7% yield.
Targa is in the growing business of gathering and processing natural-gas liquids, mostly in West Texas and along the Gulf of Mexico coast. And Targa recently announced a $950 million acquisition in the Bakken Shale, which adds a crude oil pipeline and terminal system, as well as natural-gas gathering and processing assets.
The company uses a hedging program to reduce commodity-price risk, and the acquisition adds more steady, fee-based revenue. Targa expects to pay for the acquisition with a split of debt and equity, but investors are still digesting the relatively large acquisition and shares are "on sale," Reid says.
A big plus: Targa Resources Partners' distribution coverage ratio, a measure of how much cash flow an MLP has after it pays the distribution, is healthy at 1.2 times.
Reid also likes Targa Resources (TRGP), a corporation that owns underlying MLP Targa Resources Partners' general partnership. Through this umbrella structure, Targa Resources collects a payout and gets an increasing percentage, up to 48%, of all the cash distributed by the MLP.
Essentially, as it helps the underlying MLP execute on its growth plans, Targa Resources reaps a greater cash reward -- what the industry calls "incentive distribution rights."
Investors pay a premium for that growth, but Targa Resources' valuation is in line with general partner averages. Barclays recently raised its price target on Targa Resources to $70 -- up from a current $57.42 – and expects the dividend to rise at a compound-annual-growth rate of 29%, mostly due to cash-flow growth from the MLP's large Bakken acquisition.
Energy Stocks Fueled For Growth
* Enterprise value (market value plus net debt) divided by trailing earnings before interest, taxes depreciation and amortization. Based on 1/14 closing price.
Source: Thomson Reuters, Yahoo!